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http://ssrn.com/abstract=2184254
 
 

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Implications of Returns Predictability across Horizons for Asset Pricing Models


Carlo A. Favero


Bocconi University - Department of Finance; Centre for Economic Policy Research (CEPR)

Fulvio Ortu


Bocconi University - Department of Finance

Andrea Tamoni


London School of Economics & Political Science (LSE)

Haoxi Yang


Bocconi University - Department of Finance

June 9, 2014


Abstract:     
We analyze predictors-based variance bounds, i.e bounds on the variance of the stochastic discount factors (SDFs) that price a given set of returns conditional on the information contained in a vector of return predictors. For an asset pricing model identified by its state variables, information structure and model SDF, we supply a sufficient condition under which our predictors-based bounds constitute legitimate lower bounds on the variance of the SDF of the model. Using our predictors-based bounds we analyze discount factors produced by the long-run risk, the habit and the rare disasters models. We document that consumption-based asset pricing models such as long-run risk and habit models do not produce SDFs volatile enough at the one-year horizon. When we look at long-horizons our evidence shows that it is the habit model, not the long-run risk model, that satisfies our bounds. The rare disasters model satisfies our predictors-based bounds at each horizon. As a consequence, the investment horizon and the use of conditioning information emerge as fundamental ingredients that permit either to set models apart, or to select the common behavior among apparently different models.

Number of Pages in PDF File: 65

Keywords: Predictability, variance bounds, stochastic discount factor, long-run

JEL Classification: G11, G12, G13, C5, D24, D34

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Date posted: December 4, 2012 ; Last revised: June 9, 2014

Suggested Citation

Favero, Carlo A. and Ortu, Fulvio and Tamoni, Andrea and Yang, Haoxi, Implications of Returns Predictability across Horizons for Asset Pricing Models (June 9, 2014). Available at SSRN: http://ssrn.com/abstract=2184254 or http://dx.doi.org/10.2139/ssrn.2184254

Contact Information

Carlo A. Favero
Bocconi University - Department of Finance ( email )
Via Roentgen 1
Milano, MI 20136
Italy
HOME PAGE: http://www.igier.unibocconi.it\favero
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
Fulvio Ortu
Bocconi University - Department of Finance ( email )
Via Roentgen 1
Milano, MI 20136
Italy
Andrea Tamoni (Contact Author)
London School of Economics & Political Science (LSE) ( email )
Houghton Street
London, WC2A 2AE
United Kingdom
02079557303 (Phone)
Haoxi Yang
Bocconi University - Department of Finance ( email )
Via Roentgen 1
Milano, MI 20136
Italy
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